A note on nonrenewable resource extraction under discontinuous price policy (Q1077319)

The author describes a model of the behavior of a nonrenewable resource owner-producer who seeks to maximize the net present value of an initial resource reserve of a given size. The individual producer is assumed to be a price taker with respect to regulatory authorities and, in the unregulated setting, with respect to the market. He is also assumed to face total extraction costs in a given period of time that depend solely on the period's rate of extraction. Under these assumptions, the author shows that whether faced with intertemporal price continuity or price discontinuity, the planning task of the wealth-maximizing producer is to equate the present value of each period's marginal contribution to the stream of net revenues from production across time. This rule for extraction is useful to understanding the response to a price jump such as it occurs upon the removal of price controls. The rational producer holds back at least some output until the price jump occurs and at that moment he pushes output up sharply, raising marginal extraction cost by the absolute amount of the price jump. The author illustrates his model by analyzing the U.S. natural gas price policy.